Bonds have been the world’s best-performing asset class for the past three decades as interest rates have fallen under 2% from 15% in the early 1980s, but Mike MacBain doesn’t think that will continue.

“We’ll look back 10 years from now and realize that bonds were the worst investment of a generation,” said the founding partner and portfolio manager at Toronto-based East Coast Fund Management. “Interest rates are going to be significantly higher over the next 10 years.”

He has structured the fund of roughly 70 names to have very low volatility, diversifying by company, sector and geography, while investing primarily in BBB-high rated names such as Rogers Communications Inc., Shaw Communications Inc. and RioCan REIT as well as some U.S. and international companies that issue bonds in Canadian dollars.

The manager usually avoids more cyclical sectors like airlines, energy and autos, generally underweights real estate, and targets annual returns of between 6% and 8%. Each position in the portfolio is hedged against interest rate movements.

MacBain and his team also run a “systemic risk protection package” to limit the downside if something unrelated to its bond holdings — such as the financial crisis or 2008 or the market meltdown of 2011 — causes large negative market movements. This insurance includes buying long puts on the S&P 500 and long calls on the U.S. dollar.

East Coast’s commitment to clients is to never go through any event and lose more than 5%

“From a macro standpoint, central banks are pumping an enormous amount of liquidity into the market and at some point that will create inflation,” MacBain said. “That inflation will ultimately be good for companies and really bad for interest rates.”

He also noted the money printing by the world’s developed economies is pushing people out on the risk curve.

“While we’re participating in that and making money,” he said, “it has us taking out more and more of that insurance protection to make sure that if we have a big blowoff, our investors are going to be fine.”

BUYS

Fairfax Financial Holding Ltd. (3.95%, due 2022)

The position: Long-term holding.

Why do you like it? MacBain believes Fairfax is viewed as a higher-risk insurance company because CEO Prem Watsa is not a traditional investment manager. “He’s like Warren Buffett, prepared to both buy and sell,” MacBain said.

But he noted Mr. Watsa has a strong track record of making money in both good and bad markets, Fairfax is a very consistent revenue generator, and these bonds are yielding around 4.5% in an environment where few bonds are yielding more than 3%.

“Fairfax is undervalued compared to Manulife, Sun Life and Great-West Lifeco,” MacBain added.

Biggest risk: Sustained low interest rate environment.

Paramount Resources Ltd. (7.625%, due 2019)

The position: Shorter-term opportunity.

Why do you like it? This natural gas producer owns a significant amount of land in the Montney basin, pays a healthy coupon and MacBain believes it has strong management.

“From an equity standpoint, it’s a very risky investment,” he said. “But from a debt standpoint, they only have $500-million outstanding and their asset base is probably worth six times that.”

Biggest risk: Weaker natural gas prices.

SELLS

Government of Canada 10-year bonds (2.75%, due 2022)

The position: Short.

Why don’t you like it? MacBain notes it doesn’t cost much to be short these bonds.

“With 10-year yields at 1.90%, even if you’re wrong, you’re only forgoing a 1.9% return,” the manager said. “And if interest rates go to 4%, which I think is very likely in the next two or three years, you’re going to make 20%.”

Potential positive: An equity market pullback would create a flight to quality.

Corus Entertainment Inc. (4.25%, due 2020)

The position: Short.

Why don’t you like it? MacBain sees nothing wrong with this media company’s business, but he disagrees with the pricing of its recent bond issue.

“They are comparing themselves to Shaw Communications and that is aggressive in my opinion. They should be comparing themselves to Videotron Ltd.,” he said. “The bonds are very expensive and the minute there is a bit of a crack in the market, Corus will underperform.”